EUR 850.00 For Business Accounts Only

Morningstar | Higher Equity Markets Drive a Modest Increase in Perpetual’s FVE

A moderate increase in our equity market growth assumptions because of a lower interest rate outlook prompts an upgrade in narrow-moat Perpetual’s fair value estimate to AUD 40.00 per share, from AUD 37.20. Higher equity markets have the compounding effect of contributing to funds under management, or FUM, growth in its core investments division and market-related revenue growth in its private division. Nevertheless, we expect the positive contribution from higher markets to be tempered by elevated client outflows in fiscal 2019 from the group’s Australian equity strategies. In combination, we now forecast net profit after tax, or NPAT of AUD 133.5 million in fiscal 2019, previously AUD 130.5 million. At our fair value estimate, the company has fiscal 2019 P/E of 14 times and fully franked dividend yield of 6.6%.

The major driver of our fair value estimate upgrade is that we now expect higher equity markets to contribute to FUM growing by a CAGR of about 6% over the next five years, compared with our previous forecast of about 5%, and a CAGR of about 9% over the past five years to fiscal 2018. The sharp fall in Australian and global interest rates in the first six months of 2019 and the recent change to an easing bias by central banks, including two 25 basis point cuts by the Reserve Bank of Australia, or RBA, should provide support for equity markets.

The Australian All Ordinaries Index has staged a major rebound since Dec. 31, 2018, up about 17% in the second half of fiscal 2019. This more than offsets the circa 9% fall in the first half of fiscal 2019, to about 6.5% higher for the financial year. Higher equity markets are likely to increase the investment returns' contribution to Perpetual’s FUM, market related revenues in private and boost revenues through the fair value increase in its seed and other investments, which from fiscal 2019 goes through the profit and loss statement.

While we expect the rebound in equity markets to increase the investment returns' contribution to FUM, we nevertheless don’t expect higher overall FUM in its Australian equity strategies because of elevated client cash outflows in fiscal 2019. These strategies experienced a historically high AUD 1.9 billion of net client outflows in the third quarter of fiscal 2019. These outflows were primarily from the company’s institutional clients, with one client, who we believe to be industry fund AustralianSuper, accounting for AUD 1.3 billion outflows.

The elevated client outflows are mainly a result of some asset management functions by AustralianSuper taken in-house and we expect it is partly because of the continuing trend of investors seeking out lower-cost passive investment strategies, and the general underperformance of Perpetual’s Australian equities’ strategies over one- to five years. However, we think the elevated institutional client outflows in the second half of fiscal 2019 brings forward client outflows we had expected over the next few years.

The material factor in Perpetual’s fair value estimate upgrade is better-than-expected equity market performance. The outperformance of Australia’s equity market year to date is likely a result of the RBA recently reducing its estimate of Australia’s non-accelerating inflation rate of unemployment to 4.5% and possibly lower, from 5% previously. This means the RBA thinks unemployment in Australia can fall further than previously thought, without stoking excessive inflation. This is positive for Australian equity markets because it gives more scope to the RBA to reduce interest rates in order to increase the rate of employment growth, while still being confident it can keep inflation within its targeted band. The Australian unemployment rate of 5.2% and a soft growth outlook increases the possibility of further RBA rate cuts and lower-for-longer interest rates, supporting high Australian equity market multiples.

However, we haven’t made material changes to our forecast for future investment returns. Australia’s All Ordinaries Index is already trading on high multiples and has arguably already priced in some of the lower-for-longer interest rate outlook, with the RBA rate cuts broadly expected by the market recently. Further, we expect lower interest rates, including the historically low yield of the Australian 10-year government bond, to be a response to lower expected future growth. Although we think the lower-for-longer interest rate outlook is likely to support high multiples, weak future earnings growth is also likely to hinder equity market growth and total returns.